UPDATE 1-Connecticut governor to control spending after budget fails to pass

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(Adds quotes, details of logjam, background on bonds and economy)

By Hilary Russ

NEW YORK, June 30 (Reuters) - Connecticut Governor Dannel Malloy took control of the state’s spending on Friday after lawmakers failed to pass a budget before a July 1 deadline due to discord over how to close a $5.1 billion shortfall over the next two years.

Connecticut, which has one of the lowest credit ratings of all U.S. states despite being one of the wealthiest by personal income, will continue operations under an emergency executive order signed in Hartford by Malloy, a Democrat.

“I regret that our state is in this position,” Malloy said in a televised news conference, after signing the order giving him spending control. “But I promise you this - I will not stop working.”

The impasse has some precedent. Connecticut started new fiscal years in 1991, 2003 and 2009 without enacted budgets.

This year, a huge slump in April income tax revenues compounded the state’s weak economic outlook, leading to the big deficit and downgrades from three credit rating agencies in May.

Making matters worse, Aetna Inc, the nation’s third-largest U.S. health insurer, is moving its corporate headquarters to New York City, the latest company to pull out of the state. The move takes about 250 jobs from the former insurance capital of the world despite Connecticut’s efforts to retain the health insurer with incentives. Thousands of jobs will remain on its Hartford campus.

Malloy’s contingency spending plan preserves essential services like health, safety and human services but drastically cuts other spending by at least $560 million over a full year.

Though his fellow Democrats dominate the House and are evenly split with Republicans for control of the Senate, the legislature could not craft its own budget plan or reach compromise with Malloy.

They disagree about how to close the deficit and whether to cram down costs, including for teacher pensions, onto local governments.

After lawmakers ended their regular session June 7 without a budget, Malloy asked them to come back and approve his “mini-budget,” for fiscal first quarter spending and revenues while making less severe cuts.

Instead, House Democrats on Thursday introduced a roughly $40 billion biennial budget for fiscal 2018 and 2019 that would raise the sales tax rate to 6.99 percent from 6.35 percent.

House leaders expect to return July 18 for a vote on their plan.

Senate President Pro Tempore Martin Looney, a Democrat, disagreed with Republican proposals to cut from local governments and higher education.

In the House, Speaker Joe Aresimowicz, has said not all Democrats were in agreement on which programs should be protected.

Until it has a full budget, the state is not allowed to approve new general obligation bonds, except for cash flow needs, according to the text of Malloy’s plan, released on Monday.

His plan anticipates no near-term deterioration of the state’s cash position. However, without the ability to issue new debt to replenish funds for ongoing capital projects, the state could potentially need to borrow for cash flow as the year progresses.

Such financing “could be difficult and expensive” for Connecticut without a budget in place by then, the order said.

On Wednesday, Connecticut completed its last borrowing of fiscal 2017, a $300 million private placement of variable rate debt with Barclays Capital Inc.

The credit spread on Connecticut’s 10-year debt over other top-rated municipal issuers has widened 26 basis points since the start of the calendar year to 92 basis points, according to Thomson Reuters Municipal Market Data division. (Reporting by Hilary Russ; Editing by Daniel Bases and Tom Brown)